Should I Pay Mortgage Points?

Weigh the costs of a higher interest rate against paying points for your mortgage

You've found the house of your dreams, and now you're scouting out mortgage options. When comparing interest rates and payment plans, it's important to be aware of mortgage points. Sometimes, lenders require you to pay mortgage loan points; other times, the choice is yours. Depending on your financial situation and the length of time you plan to own the home, paying points for a mortgage may or may not be in your best interest. You can gain a better understanding of points and when they work best below.

Understanding mortgage points

When you pay a mortgage point, you reduce the interest rate on your home loan. The general rule is that one mortgage loan point lowers your interest rate by a quarter of a percent.

The cost of that mortgage point is equal to one percent of the loan total. For example, on a $250,000 home loan, one point will cost you $2,500.

So, by paying $2,500, you can take your interest rate of 7.5% down to 7.25%. If you choose to pay two points, it will cost you $5,000 and lower your interest rate to 7%.

Paying mortgage points is not to be confused with paying a down payment. A down payment reduces the total loan amount whereas points reduce the interest rate. Thus, many homebuyers debate whether to pay points or just put that money toward a down payment.

How to determine your breakeven point on mortgage loan points

Using our example of the $250,000 home loan at 7.5%, let's compare some of the numbers when paying points versus no points:

If you put down $5,000 instead of paying home loan points, your monthly payment will be $1,713.08.

If you put your $5,000 toward buying two mortgage points instead of putting down a down payment, you'd have a monthly payment of $1,663.26.

The points save you $49 per month, but remember those mortgage loan points cost you $5,000 up front.

So, the next thing to consider is at what interval the cost of the mortgage points is worth it. You can think of mortgage points as a sort of investment in your loan. They earn you no equity in the short-term, but eventually they pay off by saving you money in interest.

In our scenario, your breakeven point is 102 months, or 8.5 years. If you plan to live in the house for 8.5 years or longer, paying points will save you money.

If you plan to stay in the home for fewer than 8.5 years, you'll be better off putting that $5,000 toward a down payment. That's because a down payment will reduce the loan total and give you a little equity in the home. In other words, your $5,000 earns you something right off the bat, not years down the road. By reducing your loan balance by $5,000, you'll reduce the total on which interest is charged, saving you money up front.

Use the home loan points calculator from Citizens Bank

If all of this number crunching sounds confusing, don't worry. Citizens Bank provides a mortgage points calculator that you can easily work with. Just plug in the loan amounts, interest rates and points you plan to pay to see which scenario works best for you. You can also speak with a home loan advisor at 1-888-514-2300 to learn more about points for mortgages.